"Unless dividend distribution is not a bona fide exercise or is not intended to be acted upon or is used as a cloak to conceal a different transaction, it cannot be considered a dubious method to evade taxes. Even if it ends up saving taxes, that cannot negate the effect of the lawful and legitimate action of distribution of dividend."Under fiscal laws, tax planning within the...
"Unless dividend distribution is not a bona fide exercise or is not intended to be acted upon or is used as a cloak to conceal a different transaction, it cannot be considered a dubious method to evade taxes. Even if it ends up saving taxes, that cannot negate the effect of the lawful and legitimate action of distribution of dividend."
Under fiscal laws, tax planning within the framework of the law to save taxes is allowed. The right to conduct the affairs of a business falls within the prerogative of the taxpayer. The taxman/tax authorities can only intervene in cases where there has been a deliberate attempt by the taxpayer to illegally evade taxes through use of dubious methods or colourable device.
The above principle has emerged from a catena of judgements passed by courts in India including the Supreme Court. Reliance in this regard can also be placed upon the judgement of the English Court in the case of Commissioners of Inland Revenue v. His Grace the Duke of Westminster, where the English Court observed that "given that a document or transaction is genuine, the Court cannot go behind it to some supposed underlying substance". However ambiguity cropped after the Supreme Court Judge, Justice Chinnappa Reddy, J. in the case of McDowell observed on the Westminster principle by saying "we think that the time has come for us to depart from the Westminster principle as emphatically as the British courts have done and to dissociate ourselves from the observations of Shah, J. and similar observations made elsewhere". Tax Authorities used this observation to contend that the Supreme Court judgement in the case of McDowell has diluted the concept of the Westminster principle.
The above controversy came to rest in the case of Azadi Bachao Andolan 263 ITR 706 (SC), where it was held by the Supreme Court that McDowell cannot be read as laying down that every attempt at tax planning is illegitimate and must be ignored, or that every transaction or arrangement which is perfectly permissible under law, which has the effect of reducing the tax burden of the assessee, must be looked upon with disfavour. A citizen is free to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of the law, unless the same falls in the category of colourable device, which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity. This was considered again by the Supreme Court in Vodafone International 341 ITR 1 (SC) and it was held that there is no conflict between McDowell and the Azadi Bachao Andolan and reiterated that tax planning may be legitimate provided it is within the framework of law.
Recently, this issue came up for consideration before the Kolkata Bench of the Income Tax Appellate Tribunal in the case of Maersk Line UK Limited (ITA No. 2150/Kol/2009). The Maersk Line UK Limited (the "taxpayer") sold equity shares of its wholly owned subsidiary Nedlloyd India Pvt Ltd ("NIPL"), a company incorporated in India to Maersk India Private Limited. The sale was part of the overall reorganisation of business. Just before the sale of shares, NIPL issued tax-free dividend to its shareholders (including taxpayer).
It was contended by the Assessing Officer ("AO") that payment of dividend just before sale of shares of NIPL, resulted in tax advantage to Maersk of about '94 Lakhs. The tax advantage was in the form of paying lower tax on capital gains, as the fair market value of shares had been reduced because of such dividend distribution by NIPL just before the sale of its shares to Maersk India Private Limited.Based upon the above stated facts, it was held by the AO that the distribution of dividend was nothing but a colourable device to deny legitimate share of revenue in capital gains of the taxpayer on sale of shares of NIPL to Maersk India which should be ignored while computing long-term capital gains in the hands of the assessee.
Aggrieved by the assessment order, the taxpayer carried the matter in appeal before the CIT(A). Learned CIT(A) observed that the dividends were declared in accordance with the law and the dividend distribution tax has been duly paid by NIPL. Further, the AO has failed to prove that the action of NIPL, in distributing dividends shortly before the sale, was outside the framework of law. Accordingly, CIT(A) was of the view that the AO was not justified in holding that the declaration and payment of dividend by NIPL to the appellant was a sham and colourable transaction.
The Department went in appeal against the decision of CIT(A) before the Hon'ble ITAT. It was observed by the ITAT that a transaction can be regarded as a "sham" where "the document is not bona fide nor intended to be acted upon, but is only used as a cloak to conceal a different transaction" or where "it is intended to give to third parties the appearance of creating between the parties legal rights and obligations which are different from the actual legal rights and obligations which the parties intend to create".
However on facts and circumstances of the taxpayer's case, the transaction of distribution of dividend cannot be regarded as a sham or a colourable device to evade taxes. The wholly owned subsidiary (NIPL) had sufficient reserves and cash surplus for the distribution of dividend. The decision to distribute dividends, on these facts, cannot be termed as a 'dubious' method to evade taxes; it is not a case where dividend distribution is not a bona fide exercise, is not intended to be acted upon and is used as a cloak to conceal a different transaction. The fact that this distribution of dividend also ends up saving taxes on sale of NIPL shares cannot end up negating the effect of the lawful and legitimate action of distribution of dividend by NIPL.
The ITAT also noted that NIPL has duly paid dividend distribution tax and the same has been duly accepted in its assessment. Once the taxes on distribution of dividend have been duly accepted, the character of such dividend payments in the hands of the assessee cannot be recharacterised just because by such characterisation of receipt, revenue ends up getting higher taxes. Further the ITAT while relying upon the principle of the Vodafone Case and Azadi Bachao case observed that – "Undoubtedly, the course adopted by the assessee was tax advantageous in as much as if NIPL, assessee's wholly owned subsidiary, was not to distribute dividend and sell the shares with out this exercise, the tax outgo would have been '94 lakhs more than under the present arrangement, but then every tax advantageous action or inaction cannot be treated as a colourable device unless such an action or inaction is not bona fide, it conceals the true nature of transaction or is an exercise without any commercial justification."
Therefore based upon the above, the ITAT while dismissing the department's appeal, held that the transaction to distribute dividend just before the sale of shares of NIPL cannot be regarded as a colourable device or as an impermissible tax avoidance scheme.The judgement by ITAT is a welcome ruling and reiterates the principles enunciated by the Supreme Court in the case of Vodafone and Azadi Bachao that legitimate tax planning within the framework of law is allowed, unless the same fall in the category of colourable device. The ITAT in this case held that lawful exercise of dividend distribution cannot be regarded as colourable device. It is unfortunate that tax authorities even after clear mandate by Supreme Court on the issue, are still hounding the taxpayer without any accountability whatsoever.
Disclaimer–This article has been authored by Krishan Malhotra, Head-Taxation and Vinayak Srivastava, Associate, of Amarchand & Mangaldas & Suresh A. Shroff & Co., New Delhi. The views expressed in this article are personal in nature.